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Connecting with Business Members…Via Regulations?

From Larry Middleman, CUBG President/CEO

Today, credit unions face a unique opportunity to make major strides in the business lending market. Early in 2016, the National Credit Union Administration (NCUA) released a massive overhaul of its Member Business Lending (MBL) rule, upending the agency’s long-held “prescriptive-based” approach and introducing new, more flexible “principles-based” standards.

Highlights of the final rule include:

  • Ability to waive personal guarantees
  • Removal of explicit loan-to-value limits
  • Lifting of limits on construction and development (C&D) loans
  • Clarification that non-member business loan participations do not count against the MBL cap
  • Elimination of the onerous waiver process

According to the NCUA, “it will be up to each credit union to manage MBL risks through their own policies and procedures.”

Yet, in the immortal words of Dr. Ian Malcolm (as played by Jeff Goldblum in the original Jurassic Park film), “Yeah, yeah, but your scientists were so preoccupied with whether or not they could that they didn’t stop to think if they should.”

Nowhere in the new rule is this cautionary advice more relevant than in the personal guarantee provision, which has already been implemented effective May 13, 2016 (all other provisions will go into effect on January 1, 2017).

The appropriate use of the personal guarantee waiver is among the greatest opportunities credit unions have to meaningfully connect with their business members. But it is important to use this new-found flexibility judiciously, and not simply for the sake of “being competitive” with the bank up the street. Most business loans still warrant the obtaining of personal guarantees from all owners, unless there are mitigating factors and offsetting strengths such as strong collateral positions, significant business cash flow, and a long-term track record of success.

Thanks to the NCUA’s new, more flexible approach, the new MBL rule is a tremendous opportunity for credit unions to serve members their way, in accordance with local market conditions, staff expertise and resources, and their individual tolerance for risk.

For additional questions on the new MBL regulations and how your credit union can connect with business members, contact us at info@cubg.org.

Model house with cash spread out in front of it

Lines of Credit – Collateral

by Nick Reynolds, VP/Credit Services Manager

The risks associated with business lending differ significantly from those associated with traditional consumer lending. While consumer information is still an important part of knowing your member, the types of risks associated with MBLs tend to be more varied and wider in scope. The credit union industry is expanding further into relationship lending with business members. The next logical step is to gain capabilities in lines of credit, as these are often the lifeblood of a business’ cash flow. This article is one in a series to help credit unions more clearly understand some of the unique risks.

Lines of credit are an important product to offer your business members. However, they tend to be complex, and if they are not managed properly, your member can get into hot water.

For fully revolving lines of credit, collateral will play a large part in your analysis. For example, if the member provides real estate equity adequate to fully secure the loan, the collateral analysis is pretty straightforward. You already know how to calculate a cumulative loan to value, and you can apply that as in any other business loan. This is a simple approach and allows a clear understanding of the collateral. If you are considering taking business assets as collateral for the line, your analysis will be a bit more complex. Many lenders just use book values on business assets and adjust for appropriate advance rates. Take for example a member with a $100,000 line of credit with an outstanding balance of $45,000. The borrower provides you with an account receivable aging schedule showing $75,000 in accounts receivable on their balance sheet. In most cases, the advance rate on receivables should not exceed 70%, and in this example the advance rate is 60% ($45,000/$75,000), so it would be conforming (Ex. 1).

Ex. 1: Accounts receivable held as collateral:

  • $45,000 balance / $75,000 A/Rs = 60% advance rateAverage Loan Size Total Non-Real Estate Secured MBLs

Now let’s say this same member has advanced an additional $25,000 on the line. This time, the member has pledged inventory along with accounts receivable as collateral. How much inventory would be required to cover the higher balance? Inventory is considered to be a much riskier asset than accounts receivable, as there is no guarantee that the business will be able to complete production and sell its wares. A typical recommended advance rate on inventory is 30%. So in this scenario, a collateral balance of $58,334 in inventory would be required (Ex. 2).

Ex. 2: Inventory and A/Rs held as collateral:

  • ($45,000 + $25,000) = $70,000 balance outstanding on line
  • ($75,000 x 70% advance rate) = $52,500 covered by A/Rs
  • $70,000 – $52,500 = $17,500 to be covered by Inventory
  • $17,500 / 30% advance rate = $58,334 Inventory required

If the line were fully advanced at $100,000, how much would need to be outstanding in your member’s purchase orders for you to be fully covered? Trick question! No advances should ever be allowed on purchase orders. The reason is that a purchase order, unlike an accounts receivable, does not represent a completed sale (i.e. completed delivery of a good or service with a contracted promise to pay).

For example, your member stops into the credit union and exclaims, “Wow! I have purchase orders for 200 of my finest widgets, and I only need to borrow $10,000 to pay for the materials and labor to produce them.” That is indeed exciting news for your member, but he will be better served if the funds are provided by investor capital or from some other source such as a home equity loan or a startup loan from the Small Business Administration. This financing should not be provided by your credit union, purely based on timing. Accounts receivables are due for payment in 30 days and represent a real source of repayment. Inventory represents cash that is due to be paid further out, which requires more steps before it can become a source of repayment. First they need to be sold, then packaged and shipped, then billed, and then, finally, collected. With a purchase order, the source of repayment is even further removed, and there is a great deal more uncertainty in converting that to repayment on your line of credit.

Verified and inspected equipment may represent some additional strength, and may offer additional collateral in your analysis. However, it is often used simply to provide an additional level of comfort or abundance of caution, you would typically not lend against it. For several reasons it is often quite difficult to ascertain accurate equipment values. One is that many types of equipment are specialized and for a specific use, and it may be difficult to obtain a qualified, independent appraisal of the true value. Secondly, equipment financing tends to be piecemeal, and a business with more than three pieces of equipment probably has a loan on one of them. In order to know what collateral is available, you would need to know what specific equipment already has a lien, what value is shown for it on the company’s statements, and what accumulated depreciation is shown for that piece. With this information in hand, you can then calculate the value of the collateral available to secure your loan. If available, published book values are a better gauge than relying on your client’s assessment of value.

As one of the “5 Cs of Credit”, collateral analysis is an important piece of the business lending decision, and the various types of collateral should be evaluated differently. You may have all the confidence that your member will repay the loan as agreed, but if you use the proceeds to finance the acquisition of an asset, you should take that asset as collateral. If anything goes wrong, you will be glad you did.

About CU Business Group
Established in 2002, CU Business Group, LLC, provides a wide array of business lending, deposit, and consulting services to credit unions nationwide. Based in Portland, Oregon, with offices in the West, Southwest and Eastern U.S., CU Business Group has a staff of 40 professionals and serves more than 500 credit unions in 46 states.

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CUBG Shares Resource Library With Members

After more than 13 years of working in credit union business services, CUBG has developed and collected an extensive library of tools and resources, and we are now sharing them exclusively with Member credit unions!

Our library includes a variety of resources, from policies and procedures to document templates and samples, and more. With more than 130 items for business lending, deposits, participations, and program administration, you’re sure to find valuable tools your credit union can use.

Contact us at info@cubg.org to learn more.

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Deposits Key to Becoming Full Service Provider

Deposit services are key to moving your credit union from a transactional lender to a full service financial institution for the businesses in your community.

It all starts with the business checking account but quickly moves through the process of developing and or upgrading your current package of services to a program that best fits your credit union and your members. For example:

  • Business checking accounts
  • Business savings and money market accounts
  • Account analysis
  • Online banking for business
  • Merchant bankcards
  • Business tax payments
  • Remote deposit capture
  • ACH origination
  • Sweep accounts
  • Online cash management
  • Payroll services
  • Managing deposits greater than $250,000

Of course, in assembling this package there are many important considerations to address. CU Business Group can provide the necessary expertise to evaluate these key areas:

  • Your system capabilities – what investments are needed and when?
  • Package products – do we buy it or build it in-house?
  • Volumes – what about businesses with large deposits and high cash/coin usage?
  • Pricing – how do I set appropriate fees that are competitive in my community?
  • Targeting – how do I find the businesses that I am looking for?

For more on CUBG’s deposit consulting, contact us at treasurymgmt@cubg.org.

CGI person looking at the word "review" with a magnifying glass

Expert Tip: Appraisal Reviews Critical in Loan Underwriting

From Nick Reynolds, VP/Credit Services Manager

While appraisal reviews are a necessary step to ensure that the appraisal is accurate and compliant, they are also a critical component of the loan underwriting. Many of the findings that result from performing an appraisal review are key to include in the credit write-up and in making a decision on the loan.

For example, with an appraisal on a single family residential home in a subdivision, you could conceivably have hundreds of comparable properties that are from recent sales, are close by, and result in a high-level of confidence in the appraisal figure.

In the case of a unique property such as a large church in a rural location, the story is different. The comparable sales will be similar, likely also large churches in rural areas. However, there is little likelihood of recent local comparable sales. Comparables will probably be older, and won’t represent local demographics, traffic flow, employment, etc. While the appraiser may have concluded a reasonable value, there is a great deal more variability in possible values of the property. The underwriting must acknowledge the additional risk this variability in value represents, typically by lending at a lower advance rate.

Consider the residential property example above. If you know the value within +/-2%, you can use that value in your underwriting with confidence. In the church loan, you might only have confidence that the value is representative within +/-15%. As a result, it would be recommended that you limit your advance rate to the lower value, which would indicate 15% less than your usual advance rate of 80%.

Essentially, the appraisal review helps you answer this question: How confident am I in the valuation, and can I lend at 80%? This level of confidence will be different with every appraisal, and needs to be assessed as part of the underwriting process. Your appraisal review should indicate where this might be a significant issue.

Other questions the appraisal review can help with in underwriting – Is the term of the loan within the remaining economic life of the property? Are there other unique features of the property that increase the potential viability of the value? Are actual rents significantly different than market rents? All of these issues should be pointed out in an appraisal review, and are features of the appraisal that impact the underwriting, but are not typically pointed out as weaknesses by the appraiser.

Looking at the transaction from a credit perspective and commenting on features of an appraisal that may create credit or loan structure issues for credit unions is critical, and something CUBG consistently does in our appraisal reviews. CUBG also takes a conservative view of unique properties, taking into account the difficulties that can arise in working out a loan where those properties need to be liquidated or resold.

For additional information on CUBG’s appraisal review services, contact us at info@cubg.org.

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Real-Time Monitoring Aids in Early Problem Identification

Proper risk monitoring throughout the life of the loan is critical in identifying potential problems before they become big issues. Simply doing an annual review on the loan isn’t always enough, as things can change quickly.  Frequent touches of the loan can be effective and efficient.  To aid credit unions in this, CUBG recently enhanced our risk monitoring services to provide real-time monitoring for deteriorating business credit items such as:

  • A negative change in credit score
  • Additional UCC filings
  • Recent bankruptcies
  • Adverse environmental issues on the property securing the loan
  • Plus a number of other risk areas

Any time an alert on your borrower is received, it will be sent to you via email, along with an explanation of the meaning, and suggestions for appropriate follow-up.

These frequent updates give credit unions an improved means of knowing whether there are adverse events that occur for their borrowers. This is an excellent credit practice, and of great value when talking to your examiners.

To learn more about CUBG’s enhanced risk monitoring services, email us at riskmonitoring@cubg.org.

Know the rules

MBL Regulation 723 Published in Federal Register

The MBL final rule, which significantly amends regulation 723, and will allow credit unions greater flexibility in business lending, was published in the Federal Register on Monday, March 14th.

In accordance with the change on personal guarantee requirements that will take effect on May 13, 2016, CUBG will issue a revision to the personal guarantee section of our MBL policy template and distribute to our Member credit unions in May. We will also issue a fully-revised version of our policy template in 4th quarter, to reflect the changes that will take effect January 1, 2017, and additional supervisory guidance that is expected to be released in September.

CUBG has carefully reviewed the revisions and provided a summary of the changes below.

The new MBL Regulation 723:

  • Removes prescriptive limits on business lending and eliminates the need for NCUA waivers
  • Requires each credit union to clearly lay out its credit risk tolerances and parameters in the business loan policy
  • Removes the personal guarantee requirement but requires articulation of offsetting credit strengths that justify the lack of guarantee. Takes effect May 13, 2016.
  • Includes more robust underwriting requirements for a commercial loan (business purpose) versus a member business loan (1-4 family residential)
  • Mandates use of a credit risk rating system for commercial loans
  • Replaces specific loan to value requirements with the need to obtain sufficient collateral to support the risk inherent in the loan
  • Construction & Development Loans
    • Eliminates portfolio limit of 15% of net worth
    • Expands definition of loans and the additional methods by which collateral values can be established, in addition to including more complete definition of the costs that can be included in Construction & Development loans
    • Requires policy specifics on monitoring and disbursements
  • Eliminates the need to count non-member participations purchased in the MBL cap
  • Allows CUs to extend the 15% loans to one borrower limit by 10% if the excess is fully secured by marketable collateral
  • Removes 12.25% of assets criteria for the MBL cap and leaves the calculations as 1.75 times minimum net worth needed to be considered well-capitalized (currently 7%)
  • Spells out general policy requirements for MBL oversight and expertise
  • Revises prohibited loans and conflicts of interest
  • Provides streamlined program parameters for credit unions with less than $250 million assets and low commercial loan volumes
  • Preserves the grandfathering of MBL regulations of the seven states that have their own MBL rules

The full text of the final rule is available in the Federal Register.

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Loan Pricing Webinar Recording Available

In December, CUBG held a special webinar on using loan pricing tools and techniques to improve the overall yield on business relationships.

Called Pricing Business Loans for Maximum Profitability, this special webinar focuses on how ProfitStars loan pricing methodology can help you:

  • Quantify true yield from relationship pricing
  • Understand the yield impact of negotiating loan pricing, terms, and loan structure
  • Know the effect business deposits and other services have on loan and relationship yield
  • Price loans consistently using risk-based principles
  • Better understand the true yield from your MBL portfolio and consistently report results

If you missed this complimentary session or want to share it with others at your credit union, a recording is available.

Email us at info@cubg.org for more information.

Small business - come in, we're open

NCUA/SBA Alliance to Boost Lending

The NCUA and SBA recently announced a joint initiative to help small businesses and credit unions connect, with the goals of providing small businesses with better access to capital and boosting awareness of SBA programs. Read more

Larry Middlemand, President/CEO, CU Business Group

Middleman Elected to Foundation Board

CUBG President/CEO Larry Middleman was recently elected to the National Credit Union Foundation Board. Middleman will serve a two-year term, through the end of 2016.

The Foundation is considered the charitable arm of the credit union movement and works to improve people’s financial lives through credit unions. Through Foundation grants and programs, credit unions provide widespread financial education, create greater access to affordable financial services, and empower more consumers to save, build assets, and own homes.

Read the full press release or learn more about The Foundation.